When to Use Savings to Pay Off Credit Card Debt

November 19, 2015

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Having some money saved up is a cornerstone of a strong
personal financial plan, providing a safety net in the event of emergencies and
unexpected expenses. But if you’re carrying credit card debt, it may be wise to
dip into your cash reserves to pay it off. Using non-retirement savings to get
back to black has monetary and emotional benefits you may have overlooked. Here
are five big ones.

1. You’ll save on
interest payments

The most compelling case for using cash from savings to pay
off credit card debt is the money you’ll save in interest. Because almost all
credit cards charge a higher rate than what you’d earn on money stashed in a
bank account, you’re coming out ahead mathematically.

Let’s say you have $10,000 in debt on a credit card that’s
charging an APR of 15%, and $10,000 in savings in an account that’s returning
1% interest (compounded monthly). If these numbers remain constant, at the end
of a year you will have paid more than $1,500 in interest on your credit card
and earned slightly more than $100 on your savings. By using that cash to wipe
out your debt, you’re effectively putting about $1,400 back in your pocket.

2. It will help your
FICO score

Credit card debt has a greater negative effect on your FICO
score than any other kind, because it’s factored into your credit
utilization ratio — your balances as a percentage of your available
credit. You should expect your FICO score to suffer if your debt is causing you
to use more than 30% of your credit line. The good news is that using savings
to pay off a big credit card balance could restore your score quickly — you
could see it shoot up within a month or two of getting debt-free. So using
savings to pay off debt is good option if you need to improve your score on the
double.

3. Qualifying for
financing could get easier.

Besides boosting your credit score, there’s another way
paying off credit card debt can make qualifying for financing easier:
Your debt-to-income ratio will decrease. Debt-to-income ratio is the amount
you owe on your monthly obligations compared with how much money you make. The
lower your “DTI” when you apply for a new loan, the better. If you’re able to
wipe out a monthly debt payment with your savings (and you still have enough in
the bank for a down payment on your new home, car or whatever), the better the
position you’ll be in to borrow the amount you need.

4. Your mood may
improve

Carrying credit card debt can make it tough to pay for basic
necessities, which leads to stress and tension. Research bears this out.
According to a study in the Journal of Family and Economic Issues in May:
“Household debt is positively associated with greater depressive symptoms.
However, this association appears to be driven by short-term (unsecured) debt;
we found little evidence of associations with depressive symptoms for mid- or
long-term debt.”

The study also found that credit card debt is most likely to
have negative psychological effects on people ages 51 to 64, people who are
single, and people who have no postsecondary education. It’s not a guarantee,
but using your savings to pay off debt might help your emotional state —
particularly if you fit one of the profiles cited by the study.

5. You’ll be better
situated to save in the future

Yes, you’re taking a step backward in your savings goals by
using using some of that cash to pay off credit card debt. But if you can get
past the short-term pain, you’re actually making it easier to save in the
future. Now you can shuttle the money you were using to pay down your credit
card balance to savings instead. This, of course, should be added to the amount
you normally sock away each month to pump up your account balance even faster.

It’ll take time to recover what you used to repay your debt,
but you’re likely to profit (literally) from taking the plunge.